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Economic Update: South East Asia

The ICAEW Economic Update: South East Asia, is a quarterly forecast for the region prepared directly for the finance profession.

Q2 2019 Summary

Export and growth prospects deteriorate amid renewed US-China trade tensions

  • Amid slowing global trade and escalating US-China trade tensions, we expect GDP in the South East Asia (SEA) region to slow from 5.3% in 2018 to 4.8% this year, before moderating to 4.7% in 2020.
  • A sharp policy reversal by the US Federal Reserve and subdued inflation across the region have opened the door for easier monetary policy across the SEA region. We expect Singapore to join Malaysia and the Philippines and move to a more accomodative stance with others to remain on hold for longer.
  • A further increase in trade tensions, such as the US imposing tariffs on all Chinese imports, would see a much more prominent slowdown in regional growth. As a small open economy heavily dependent on exports, the Singapore economy would be most negatively affected and would likely dip into recession in 2020.

US-China tensions have recently re-escalated. The US hiked the tariff rate from 10% to 25% on US$200bn of Chinese imports, with China retaliating by raising the tariff rate on US$60bn of imports from the US to 5%−25%. The US has also published an additional US$300bn list of goods, implying that nearly all Chinese imports could face higher tariffs.

Recent developments show how difficult it is to achieve agreement on a range of policies and practices on technology, market access and intellectual property, in a way that goes far enough for the US side, and is acceptable to China. It is still possible that a trade deal will eventually emerge. But, given the souring of the mood, for now we assume that the existing tariffs will not be lifted any time soon.

The re-escalation in trade tensions comes at a time when export growth across the SEA region is already in the doldrums from weaker Chinese import demand, a slowdown in the global ICT cycle, and the increase in trade protectionism over the past year. Indeed, total export volumes were, on average, 1% lower than a year ago in Q1 with uncertainties over external demand also likely to have weighed on firms’ production and investment intentions in the quarter. Overall, GDP growth for the SEA region as a whole slowed to 4.6% year-on-year in Q1, down from 5.3% growth recorded in H1 2018.

The deterioration in export momentum across the region has continued into the second quarter, with only Vietnam bucking the trend. However, even its growth has decelerated from last year. Looking ahead, we expect exports and overall economic growth to come under further pressure from weaker Chinese import demand, the slowdown in the global ICT cycle and increased trade protectionism over the past year.

SEA Goods Exports (USD)

Doors open for central bank policy easing

We expect domestic demand to somewhat cushion the drag on growth from weaker exports aided by accommodative macro policies. Indeed, a sharp policy reversal by the US Federal Reserve and subdued inflation across the region have opened the door for easier monetary policy across the SEA region. Central banks in the Philippines and Malaysia have already reduced policy rates by 25bp each amid global uncertainties.

However, while inflation in the Philippines is back within the 2-4% target range, we believe that scope to reverse last year’s 175bp in rates is limited, as it is still vulnerable to renewed emerging market risk aversions and USD strength. The recent rise in oil prices also poses upside risks to inflation. As such, we look for only one more rate cut in Q3.  In the case of Malaysia we see the recent loosening in policy as having been a preemptive move, and in the absence of worsening economic conditions we do not expect any further easing this year.

Following a pause in April, we also expect the Monetary Authority of Singapore (MAS) to also ease policy at its next biannual meeting in October, shifting to a more modest appreciation bias in its SG$NEER, a trade-weighted basket of currencies agains the SGD.
Meanwhile, although both Bank Indonesia and the Bank of Thailand have the scope to reduce interest rates, we look for both to remain on the sidelines. In particular, the BI remains focused on external stability and supporting the currency.

Expansionary fiscal policies to counter weaker growth

We also expect fiscal policies to be more supportive of regional domestic demand over 2019−20 with infrastructure investment to partly offset more cautious investment by businesses. We expect government spending to rebound in the Philippines following a delay in its approval this current year. In Indonesia, with Jokowi winning his re-election, we expect the postponed infrastructure projects to restart, leading to a recovery in investment. A notable exception is Malaysia, as an ongoing review of infrastructure projects and fiscal consolidation targets will limit any support this year into next.

On balance, we expect regional South East Asia GDP growth to moderate to 4.8% this year from 5.3% in 2018, with growth set to ease to 4.7% in 2020. As a small open economy heavily dependent on exports, we expect Singapore to experience the sharpest slowdown, with GDP growth set to moderate from 3.1% in 2018 to 1.9% in 2019. Meanwhile, although growth is set to ease in Vietnam, at 6.7% this would place it as the fastest growing SEA economy.

Asia GDP Growth

Singapore: Export outlook deteriorates damaging growth prospects

GDP growth was revised down slightly to 1.2% year-on-year in Q1 from the advanced estimate of 1.3%, reflecting somewhat weaker than estimated service sector activity. While the Q1 GDP outcome represents a moderation from the 1.9% growth in Q4, sequentially growth was up a solid 0.9% quarter-on-quarter, compared to a 0.2% contraction in Q4 2018.

Looking at the details, the picture was mixed. Household spending remained surprisingly resilient with growth accelerating to 4.2% on the year. That said, sequential growth has eased and demand for durable goods, such as motor vehicles, is particularly weak. Meanwhile, non-residential and infrastructure construction were strong and despite residential investment continuing to contract, construction growth was positive for the first time in two and a half years.

However, the impact of weaker global trade and US-China trade tensions are increasingly being felt. Total exports were 2.1% lower than a year ago in the first quarter, driven by a sharp fall in goods exports. Meanwhile concerns over the outlook for external demand saw investment in machinery and equipment fall and firms opting to reduce stocks.

Looking ahead, the outlook for exports is weak and following more tariff hikes by the US and China we now expect more downward pressure on exports and overall economic growth in the coming quarters than we previously envisaged.

Singapore: GDP, Exports and world trade

Meanwhile, we look for domestic demand to partly offset the drag on growth from exports aided by more accommodative macro policies. Indeed, the outlook for construction, outside of the residential sector, is positive given the ongoing recovery in non-residential construction. We also expect ongoing public infrastructure projects such as the North-South Corridor to continue to support construction over the next 18 months. However, investment in machinery and equipment is likely to be more subdued despite government measures to encourage investment, particularly in adapting to Industry 4.0, as businesses are likely to remain cautious given the weaker global trade backdrop. Overall, we expect GDP growth to slow to 1.9% in 2019 before rising to a below trend rate of 2.2% in 2020.

MAS to ease policy as export outlook dims further

Given benign inflationary pressures and the more challenging export outlook, we expect the MAS to reduce the appreciation bias of its SG$NEER. Unlike most central banks the MAS’ key policy tool is the SG$NEER, which is a trade weighted basket of undisclosed currencies against the SGD.
Similar to the tightening undertaken in 2018, where the slope was raised ‘slightly’ we suspect the authorities will refrain from explicitly stating the pace of appreciation. Based on our estimates we expect the slope will be reduced to around 0.5% from 1% currently. As such we expect USD/SGD to end 2019 at around 1.39, which is consistent with the SG$ moving towards the centre of its policy band.

Vietnam: FDI and manufacturing to remain significant drivers of growth

Economic momentum moderated to 6.8% year-on-year in the first quarter of 2019, below the 7.3% increase in Q4 GDP. Growth in the quarter was underpinned by ongoing strength in the manufacturing sector, solid service sector activity and improving agriculture output.

While the rest of the SEA economies have recorded sharp falls in exports, merchandise exports in US$ terms were 10.4% higher than a year ago in April. This was despite a double-digit fall in crude oil exports. However, this still marks a deceleration from the 13.3% growth recorded in 2018. Moreover, we expect momentum to continue to trend lower given weaker Chinese import demand and increased trade protectionism. The recent re-escalation in US-China trade tensions will add further downward pressure on external demand. Indeed, while trade diversion may temporarily benefit Vietnam, it is still highly exposed to China. Total exports to China in value added terms accounted for 10.3% of GDP in 2017, of which around 85% was used to meet Chinese domestic demand.

However, external demand is unlikely to fall off a cliff and we expect FDI and manufacturing production to remain significant drivers of growth. According to the Foreign Investment Agency, disbursed FDI picked up 9.8% y/y to a three-year high of US$2.6 billion in the first two months of 2019, with the manufacturing and processing sector garnering the most interest from foreign investors.

Moreover, we expect inflows to remain strong over the medium term due to the country’s close proximity to China and positive labour dynamics, including low relative wages. Its participation in trade agreements, notably as part of ASEAN, and policies to attract FDI are also favourable. Vietnam’s infrastructure metrics are also improving. But structural reforms are needed to improve firms’ ability to do business in the country as well as ensure adequate education and training to enhance the scalability of production, notably in telecommunications, which is one industry where Vietnam has a comparative advantage.

Asia Average Annual Earnings, US$ per person

Domestically, we expect demand to remain healthy over 2019−20. Household spending will remain solid amid stable inflation and rising incomes, while sustained tourism should support the service sector. Overall, we forecast GDP to grow by 6.7% this year, with a modest deceleration over 2020−21 to 6.1% pa.

SBV to stay on the side lines

In terms of monetary policy, we expect the State Bank of Vietnam (SBV) to keep its refinancing rate unchanged at 6.25% this year. At the current policy rate, the monetary policy stance remains conducive to the continuation of economic growth and, while the inflation outlook remains moderate, the strong GDP growth eases pressure on the central bank to add more stimuli to achieve an annual growth target of 6.7%. Further out we look for the authorities to raise the policy rate to 6.75% by late 2020, to reduce financial stability risks.

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